Pre-MPC Commentary - Hold Predicted Even Amid Higher Inflation

The
fourth Monetary Policy Committee (MPC) meeting of 2018 will conclude later
today. In a year when prior expectations of monetary stimulus to boost growth
have made way for a more hawkish outlook amid rising inflation and an unwelcome
external backdrop, the MPC has voted to hold all policy levers up to this
point, even with the shadow of elections looming.

There
was a seven/three (hold/hike) split at the July meeting, and although we
anticipate an even closer vote, we do not expect the committee to tighten
monetary policy as the key variables (inflation and exchange rate market) have
mostly evolved in line with expectations formed in prior months. Therefore, we
predict another HOLD decision.

Nigeria
to ride out emerging market storm without a rate hike Emerging & Frontier
Market currencies have come under significant pressure in 2018. The Turkish
Lira and Angolan Kwancha have depreciated as much as 40% so far this year while
the Russian Rouble (-13%), South African (-12%), and Ghanaian Cedi (-9%) have
also suffered. Indeed, only Egypt (-1%) and Nigeria (-1%) have been relatively
stable, and the former is still under an International Monetary Fund programme
that forced a large prior devaluation.

The
reason for this is two-fold. The first is the accelerating trade war between
the United States (U.S.) and China. The U.S. placed a new round of tariffs on
$200 billion worth of Chinese goods (China imports roughly $130 billion worth
of goods from the U.S.) and this could weigh on the Chinese economy which
remains a key trading partner for many Emerging Markets.

The
second is that U.S. monetary policy is getting much tighter and much quicker
than anticipated. The Federal Reserve (Fed) has hiked interest rates twice
already this year and raised their year-end upper bound forecast from 2.25% to
2.50%, which would probably lift the Fed rate above core inflation for the
first time in a decade. Moreover, the 2019 outlook looks similarly hawkish,
with the Fed projecting three hikes for the year. In summary, the Fed is likely
to deliver on its seven promised hikes through to 2020 (three in 2019, and two
in 2020) which would put the Fed fund rate around 3.50%-3.75%.

Amid
all of this, Emerging Markets have experienced substantial capital outflows in
the last six months, but the response of central banks has been mixed.
Non-African central banks have moved swiftly to hike interest rates, with India
and Indonesia raising rates by 25bps each in August to 6.5% and 5.5%
respectively while Russia did likewise in September to 7.5%.

Turkey
has also increased its base interest rates from 8% at the start of the year to
24% in September, albeit in an effort to assuage a severe currency crisis. In
contrast, South Africa, Ghana and Angola all held interest rates at their
September meetings. We anticipate a similar response from the Central Bank of
Nigeria (CBN) as it is arguably better equipped to weather the capital
reversals than many of its African peers.

Despite
notable pressure on Eurobond yields in recent months, Nigeria’s external
position is decent; current account balance is modest at 8% of GDP and external
reserves— though declining—are still strong at $49 billion. In addition, oil
earnings are resilient as oil exports have recovered and global oil prices
remain at favourable levels.

The
only additional sour spot is the onset of election season which comes with
risk-off sentiment among foreign investors, but it is likely that the capital
markets (the most vulnerable to transient foreign flows) have already felt the
brunt of this as the market has lost 23% since its January peak.

In
summary, although we acknowledge the impact of U.S. monetary tightening and the
trade war on capital flows and the exchange rate, we expect the CBN and markets
to weather the storm in the medium-term.

Inflation will tempt voters

The
dominant factor in the monetary policy equation is inflation and, on this note,
there is arguable case to hike. Nigeria’s annual inflation rose from 11.1% in
July to 11.2% in August as the effect of a weaker base was felt- though
month-on-month inflation cooled from 1.1% to 1.0%.

Food
price pressure remains the primary concern as many farmers have been displaced
by conflict and flooding in the Middle Belt. In addition, the coming election
season is likely to introduce sizable liquidity injections as candidates ramp
up spending. Even with a forecast of little change to m/m inflation in the
coming months, annual inflation would still rise as a result of the weak base
from last year.

Our
forecast for December inflation is 12.8% y/y, and we project further rises
going into 2019. Despite this bearish inflation outlook, we do not anticipate
any change in monetary policy as the committee anticipated these trends.
Nevertheless, we note that earlier onset of the reversal in inflation trend may
sway a swing voter.

Key
variables trend as expected, MPC to hold rates The evolution of the external
environment and domestic inflation present a fair case to hike interest rates,
but we anticipate a hold decision because the key variables have evolved as
expected. To clarify, we argue that the MPC has largely anticipated the
observed trends and the fruition of expectations ought not to alter policy
path.

Notably,
the reversal in inflation was expected with the CBN Governor Godwin Emefiele
saying, “My immediate predisposition is for further tightening of domestic
policy stance to rein in expected inflation and ensure FX market stability,” in
his May statement. In addition, those that voted to hike rates at the July
meeting did so in order to anchor inflation expectations.

In
his July statement, Joseph Nnanna explained that he voted to raise the monetary
policy rate (MPR) by 50bps to “signal the need to anchor inflation
expectations”. Finally, it is clear that inflation and external conditions
would drive a shift in committee consensus. The statement made by Isa-Dutse
Mahmoud in his debt MPC meeting read, “If the liquidity situation and external
conditions worsen in the coming months, we should raise rates and use other
instruments as well to reduce the negative impact on inflation and exchange
rates.”

In
our view, neither external conditions nor domestic inflation has changed
sufficiently to warrant a shift in consensus vote, which would require a swing
of three voters (or two voters and the CBN Godwin Emefiele). Thus, we expect
the vote to be closer but for the result to be the same: a HOLD decision.